In a decision recently rendered, In the Matter of the Petition of Stewart’s Shops Corporation, the New York State Tax Appeals Tribunal upheld an Administrative Law Judge’s (ALJ) determination that the taxpayer was not entitled to tax deductions for premiums paid to its wholly-owned captive insurance company subsidiary for Corporation Franchise Tax purposes under Article 9-A.
During the years under audit (2006 – 2009), Stewart’s, the convenience store and gas station operator, owned 100% of Black Ridge Insurance Corporation (BRIC) which was a pure captive insurance company licensed by the New York State Insurance Department and authorized to do business in New York. Prior to the formation of BRIC, Stewart’s had a feasibility and actuarial study performed to determine the viability of a captive insurance arrangement to cover certain risks. After BRIC was licensed as a captive insurance company, Stewart’s finalized the lines of insurance BRIC would provide to it based upon recommendations from its outside consultant and its historic insurance needs. BRIC was not included in Stewart’s combined franchise tax returns for the years at issue (insurance companies are precluded from filing combined with general corporations taxed under Article 9-A, as they are taxed under Article 33 of the New York Tax Law), although it filed as a member of the consolidated Federal returns. The intercompany transactions related to the insurance were eliminated on its Federal returns.
On audit, the Division of Taxation & Finance determined that the payments by Stewart’s were not premiums paid for bonafide insurance, because it found that there was no risk-shifting or risk distribution, typically an indication of a traditional third-party arrangement in which the risk of loss shifts from the insured to the insurer, who will then distribute the risk among its various policy holders. The ALJ concurred, and concluded that, although the risks covered by the arrangement between Stewart’s and BRIC were insurable and the arrangement met commonly accepted notions of insurance, the arrangement lacked risk-shifting and risk distribution, two essential elements of insurance under federal case law. The ALJ observed that the arrangement between petitioner and BRIC lacked these features because of its parent-subsidiary structure. Under this structure, since the risk of loss still ultimately remains with the parent, there is arguably no risk-shifting. Arguably there is also no risk distribution since Stewart’s is the only party that is insured under this arrangement.
The Tax Tribunal upheld the ALJ decision to deny the tax deductions claimed.
New York State has been actively auditing companies with captive insurance subsidiaries for several years, seeking to deny the tax benefits of these arrangements. The use of Federal concepts to deny a deduction is not at all unusual, since the starting point for state taxes is Federal taxable income. The Stewart’s decision sets a precedent and can be expected to be applied to similarly situated taxpayers involving captive insurance company subsidiaries. Please contact your Mazars USA professional or our State & Local Tax Services team for additional information.